With third quarter 2016 now wrapped up and economic data largely in, indicators show that the US economy is growing at a modest pace. Other than the housing market, macro data published in the third week of October was generally positive. The economy picked up, after a slow first half start, largely due to consumer spending. Capital expenditures remain a drag, and while the pullback in mining spending accounted for a meaningful source of weakness over the past several quarters, business investment, excluding energy, also decelerated. Third quarter earnings took center stage in the first half of October, with roughly a quarter of the S&P 500 having reported results.

Third quarter earnings reported so far, are better-than-expected

Predominantly driven by positive surprises from banks. Based on Factset data, third quarter earnings for the S&P 500 declined 0.3%, representing the sixth consecutive quarter of year-over-year declines, but the trend was better than the low single digit decline expected going into the reporting season. Sales trends have also improved, showing low single digit growth during the quarter.

Exhibit 1: Quarterly profit margins for S&P 500 stocks (%)

Source: Bloomberg as of 25/10/2016

If this positive trend continues, it will mark the first time the index has shown revenue growth since the fourth quarter of 2014. Consumer Discretionary and Healthcare sectors are targeted to remain the highest revenue growth industries, while Energy is the worst. Excluding Energy, third quarter revenue growth would have been over a percentage point higher.

The biggest surprise so far this reporting season came from the Banking sector

Third quarter capital markets revenues were the best results posted in seven years. Fixed income trading rose, ahead of regulatory reforms and central bank actions, and returns on equity improved across the board. Banks’ management teams are optimistic on the outlook for future earnings, noting solid backlogs and pipelines.

So far this year, global M&A volume is down 26% versus the prior year, although the announcement this weekend of AT&T’s USD 107 billion acquisition of Time Warner has placed large scale deals on the front burner again. Despite the significant earnings outperformance during the third quarter, trading and investment banking revenues so far this year are lower versus the prior year, resulting in management teams remaining focused on cost management initiatives.

Housing data in the third week of October was mixed. Housing starts were weaker than expected, with weakness primarily in multifamily starts. Existing home sales and building permits were ahead of expectations, of which the latter should be supportive to starts in the upcoming months. The price premium between new and existing homes is at historic highs, which has caused some affordability challenges for homebuyers.

Homebuilders’ confidence declined 2 points to 63 points in October, but the single family market outlook is still supported by lean inventory levels, improved permitting activity, low mortgage rates and a solid outlook for jobs.

Following a 0.2% increase in August, the 0.3% increase in consumer prices in September was due largely to higher energy prices, while core consumer prices increased only 0.1%, pushing the annual core inflation rate back down from 2.3% to 2.2%. The modest decrease supports the more cautious outlook from the Fed and makes an interest rate hike in November unlikely.

The third quarter earnings season is offering a glimmer of hope for revenue growth and a reversal of negative earnings trends.

On the macroeconomic front, except for the housing data, this week’s economic releases were generally positive. While residential investment will likely be a drag on 3Q16 GDP, higher than expected permits supported by low inventory levels, healthy buyer traffic and solid job growth, should drive construction spending in the coming months.

The US continues to chug along, slow and steady, with the expansion driven largely by the consumer, while business spending and manufacturing remain lethargic.